Thursday, March 5, 2009

Thursday Morning Update

Stocks rallied yesterday, in part on news that the market was "oversold" to near-record levels, equalling that of two major market bottoms, 1974 and 1987. However, the financial stocks sank. Tokyo rallied but Asia as a whole was mixed. Europe is sharply down again and U.S. futures are down as well.

Gold is in a short-term downtrend, but continues to outperform the stock market. Treasuries are in a worse downtrend than gold, but from a more extended moon shot up in price, down in yield during the panic late last year.

What's going on?

Econblog Review ("EBR") continues to believe that stock markets have collectively "decided" that the financial and monetary authorities are pursuing improper policies. Investors know that debasing the currency is at best a short-term expedient. They know that economies have cycles, and the bigger the boom, the bigger the bust can be without representing descent into economic chaos.

They know that the recession was relatively mild until last summer, when the U.S. Government, following the one-time borderline legal Fed actions in the Bear, Stearns collapse, began intervening in unprecendented ways in the financial system, leading to what markets hate most: FUD- fear, uncertainty and doubt. Thus while the recession feels unending, year-on-year metrics are in most cases still positive.

But governments continue to follow the old paradigm that credit makes the economic world go round, when the truth is that it is savings and equity that make capitalism work. Money-lending is simply a means of providing savers with an outlet for their savings to be used more efficiently than the generator of capital wants to or can do at the moment. There is, however, nothing in capitalism that suggests that anyone should routinely borrow money from a financial institution for life's necessities or should ever borrow money at a high interest rate for any luxury.

The entire economy fell prey to the Merchants of Debt. Even large corporations got hooked on living on the financial edge by relying on a positively-sloped yield curve and borrowing money in the money markets for routine, predictable things such as payroll. This is in contrast to Microsoft, for which Bill Gates used to insist on having one year's worth of operating cash in the bank at the start of the year, so that he would not be dependent upon unpredictable credit markets.

Thus the markets shudder when they see the following out of the two leading Anglo-Saxon countries in the news today (both from Bloomberg.com):The deepening recession is putting greater pressure on banks and in response many banks are pulling back on credit,” Geithner said in testimony to the Senate Finance Committee. “Critical parts of our financial system are working against recovery.”

The strength of an economic recovery hinges on the government’s ability to supply financial companies with fresh capital to get credit flowing again, the Treasury chief indicated.

EBR begs to differ. Banks should pull back on extending credit. Both the banks and the U.S. Government are close to tapped out. Barack Obama said when campaigning for President that we need to tighten our belts. He was right. Credit will flow when there is good upside for a borrower and a lender. You can count on it. The economy does not suffer from anorexia nervosa. It's simply on a diet after years of over-eating.

From England comes what likely is the U.S. economic future: overtly debasing the currency, and proud of it:

The Bank of England reduced the benchmark interest rate to the lowest ever and said it would start purchasing 75 billion pounds ($105 billion) in assets, printing money to fight the recession.

The bank’s nine-member panel, led by Governor Mervyn King, cut the rate a half point to 0.5 percent, the lowest since the bank was founded in 1694. . .

“In these highly uncertain times, there are merits to stimulating the economy through a variety of different channels,” King wrote in a letter to Chancellor of the Exchequer Alistair Darling dated Feb. 17 and published today.

In conjunction with this onslaught of more governmental meddling, the subscription-only RGE Monitor yesterday had not one but two articles extolling the benefits of inflation. One of the articles had the nerve to assert that a two trillion dollar deficit was no big deal.

It's as if we have learned nothing from the 1970s. Printing money is just another shot of heroin to the debt junkie. Great Britain in the 1930s had a mild depression and never adopted Keynesian policies. The U.S. adopted them and had no economic recovery until winning WW II.

The two durable U.S. economic expansions after WW II came in the 1950s and 1960s, when all aspects of the economy and government had very little debt (except for Federal war debt), and the 1980s and 1990s, when Federal debt as a % of GDP was at a post-war minimum and consumers were relatively unleveraged.

Regardless of short-term up-moves in stocks or even a 1970s-style bull market, strategic investors should avoid the stock market. There are still too many voices calling for a bottom, too many uninformed market historians who assert that stocks have rarely been cheaper, and too large a financial services industry making a parasitic living trading stocks for this to represent a durable market bottom that you can count on.

Treasuries may or may not do well. Any bonds that lack the full faith and credit guarantee of the U.S. Government are believed at EBR to be risky and should not be bought with new money except at crisis prices.

If markets move to the level of panic and further deleveraging seen last fall, gold may well get dumped. If in suh a scenario its relative strength is good compared to Treasuries and stocks, especially financial stocks, then it should be accumulated, both in physical form to be held securely as personal property, and as an investment, such as through the "GLD" exchange-traded fund.